Statement by Jeroen Kremers, Executive Director for the Former Yugoslav Republic of Macedonia

This paper discusses the Former Yugoslav Republic of Macedonia’s (FYR Macedonia) Request for a Stand-By Arrangement and Extension of Repurchase Expectations. The authorities have asked the IMF to support an ambitious program that includes structural reforms that address the root causes of FYR Macedonia’s weak performance. On the macroeconomic front, the near-term aims of the program are to strengthen the exchange rate peg by increasing foreign exchange reserves and to manage the transition from official budget financing to market-based financing. The program also aims to secure medium-term fiscal sustainability.


This paper discusses the Former Yugoslav Republic of Macedonia’s (FYR Macedonia) Request for a Stand-By Arrangement and Extension of Repurchase Expectations. The authorities have asked the IMF to support an ambitious program that includes structural reforms that address the root causes of FYR Macedonia’s weak performance. On the macroeconomic front, the near-term aims of the program are to strengthen the exchange rate peg by increasing foreign exchange reserves and to manage the transition from official budget financing to market-based financing. The program also aims to secure medium-term fiscal sustainability.

The Macedonian authorities would like to express their appreciation for staff’s comprehensive report and the candid exchange of views during the discussions of the economic program for 2005-2008 proposed to be supported by a new Stand-By Arrangement. Macedonia’s record of macroeconomic stabilization has been advanced and the main objective of the previous SBA - a return to a sustainable fiscal position after the 2001 security crises - has been attained. By implementing all prior actions in a timely and consistent manner, the authorities have reconfirmed their strong commitment to sound economic and financial policies. Against this background, they request support for a three-year SBA and Extension of Repurchase Expectations.

The authorities attach great value to a close relationship with the Fund and the requested program is designed to sustain macroeconomic stability, to enhance domestic and international credibility, increase investors confidence, and to improve external competitiveness and accelerate growth. In this vein, the authorities’ ambitious program includes structural reforms aimed at addressing the root causes of Macedonia’s modest growth performance. The authorities believe that the proposed program realistically reflects the recent economic developments in Macedonia and the challenges ahead, and, as always, consent to the publication of the report.

The new economic program represents a new stage in Macedonia’s transition to a market economy, its relations with the International Financial Institutions, including the IMF, and its further integration in the global economy. Recent economic and political developments have marked a gradual but consistent shift to sustained macroeconomic stability, as reflected by the March 2005 local elections, which confirmed the progress in implementing the Framework Agreement. Furthermore, recent international engagement, such as the application for NATO membership and European Union candidacy, as well as key reforms supported by the proposed program enjoy broad support across society. This gives confidence that the next parliamentary elections will not disrupt the reform agenda.

The August 23 Standard & Poor’s upgrade of Macedonia’s long-term foreign and local currency sovereign credit ratings1 reflects confidence in the ongoing progress of structural reforms, macroeconomic stability, and the downward trend of Macedonia’s public debt levels.

Notably, fiscal consolidation contributed to the improved economic situation from 2003 onwards, supported by price stability and a stable exchange rate. Inflation has been retained at low single digits since the mid-1990s, reaching a very low level in recent years. The economic growth achieved over the last two years, though still below potential, is expected to increase to 3¾ percent in 2005, and further accelerate to 4½ percent under the new program between 2005-08. Staff estimates that the acceleration in GDP growth will be accompanied by a reduction of the external current account imbalance from 9.4 percent of GDP in 2004 to 4.8 percent of GDP in 2008.

Fiscal policy

Following a tight fiscal stance in 2003, the authorities realized an impressive consolidation by undertaking politically difficult measures, among others, increasing taxes, raising utility prices and reducing expenditures. The central budget deficit was significantly reduced from 5.3 percent of GDP in 2002 to 0.9 percent of GDP in 2003 and a surplus in 2004. For 2005, the authorities have passed a supplementary budget with a deficit of 0.4 percent, which is in line with the medium-term fiscal program. This represents a substantial tightening relative to the original budget deficit target of 1.2 percent of GDP. Although pressures to increase expenditures persist, the authorities remain committed to maintain fiscal discipline, in light of the large current account deficit, financing constraints and uncertain future expenditures.

The proposed program builds on the successful fiscal adjustment under the previous SBA by targeting a medium-term central government deficit (0.6 percent of GDP) that will reduce the public debt ratio. The debt sustainability analysis shows that debt dynamics are generally favorable. Against this background, the authorities’ financial program aims at managing the transition from dependence on official balance of payments support to reliance on market financing, while maintaining the fixed exchange rate as anchor for price stability. In this regard, the authorities are fully aware that the successful transition to market financing will require not only fiscal prudence, but also the development of a debt management strategy, and have established a Public Debt Management Department in the Ministry of Finance. The authorities’ initial strategy focuses on the development of the domestic security market and entering the Eurobond market later this year.

An important element of the broader fiscal reform agenda is the implementation of the comprehensive reform of the tax administration in line with FAD recommendations. In this area, the authorities intend to broaden the tax base by cutting back on tax incentive schemes, harmonizing the base and unifying the collection of personal income tax and social contribution. The implementation of these critical measures will be closely monitored by the Fund, including through benchmarks and performance criteria, consistently spread over the life of the program. To this end, the government has approved the new Law on Tax Administration Procedures, which is envisaged to be passed by the Parliament by the end of the year. This will improve the efficiency of the Public Revenue Office (PRO) and broaden its authority, allowing it to impose penalties and seize assets without requiring prior court action.

The authorities plan to improve the use of scarce administrative resources in the collection of the social insurance contributions. They will gradually consolidate the collection activities of the pension, health and unemployment funds and the PRO. By mid-2006, a new Large Contributor Office will be created, comprising separate units for the Pension and Disability Fund (PDF) and the Health Insurance Fund (HIF) (structural benchmark).

On the expenditure side, the authorities plan to keep public wages and public hiring under strict control to ensure that the share of salaries in tax revenues is maintained at the level of the 2005 supplementary budget. In line with previous Board recommendations, steps have been taken to increase the efficiency, transparency and fiscal soundness of the health care system. In this connection, as from May 2005, monthly HIF budget execution and financial reports of the seven largest Public Health Institutions (PHI) have been published on the HIF website, and starting with the 2006 budget, the HIF will report on budget execution, including transfers to PHI’s. To further improve transparency and financial accountability of the system, the seven large PHI’s will prepare budgets for 2006, for approval by the Ministry of Health in consultation with the HIF and the Ministry of Finance (performance criterion).

Monetary policy and exchange rate regime

The National Bank of the Republic of Macedonia (NBRM) conducts a monetary policy that, in combination with the tight supplementary budget and expected inflows, will allow a modest increase in the official foreign exchange reserves. The increase in reserves and proceeds from the Eurobond issue are expected to result in an increase in the import coverage from 2.9 months in 2004 to 3.6 months by the end of 2005. Broad money will grow in line with the recent trends in velocity, and the level of euroization is expected to remain constant. The authorities believe that this will allow meeting the reserves target without need for increasing interest rates. However, the NBRM stands ready to use all necessary instruments to meet the program targets.

The staff reports that the authorities considered the option of a more flexible exchange rate regime and recognize the merit of this exercise. However, they would like to reiterate that the peg has served the country well as a clearly defined monetary anchor, and will continue to do so. In examining the alternatives, the NBRM has the view that inflation or monetary aggregate targeting would be premature given the emerging financial market and the unpredictability of the monetary transmission mechanism.

Under the new program, the independence of the central bank will be further strengthened by increasing its capital base and establishing rules that will help maintain its financial stability. In this regard, the authorities have agreed to a package aimed at underpinning its capital base and improving its profitability.

Financial sector development

The development of the treasury securities market is a core priority of the program because it affects the government’s capacity to borrow, the scope for central bank open market operations and the investment opportunities for firms, households and banks. In order to develop this market, the NBRM is promoting secondary trading and the introduction of repurchase agreements. Also, by the end of the year, the government and the NBRM will agree on a plan to phase out central bank bills and use treasury securities for open market operation (structural benchmark). The central bank has finalized all legal and accounting requirements for introducing repurchase agreements with treasury bills, and it welcomes IMF technical assistance on issues concerning repo transactions.

The staff correctly notes that, while continued credit growth is a positive development, there is a need for careful management of the implied risks. To this end, the authorities concur with staff that greater attention should be paid to strengthening banking supervision. The NBRM has already assessed borrowers’ foreign exchange risk exposure as part of its regular supervision activities. Looking forward, the Macedonian authorities will undertake measures to strengthen banking sector governance. As a first step, they will amend the Law on Banks to give the NBRM authority to enforce proper requirements on existing bank shareholders and to strengthen procedures for bankruptcy. Since strengthening of the financial sector is a core element of the program, the amendment of the Banking Law is a prior action for the second review, and the development of the Supervisory Development Plan a structural benchmark.

Structural reforms

The proposed program relies on ambitious structural reforms aimed at raising productivity growth, fostering entrepreneurial activity and eliminating rigidities in the labor market. The overarching objective of the authorities’ medium-term program, which is in line with the 2004 Ex Post Assessment, is to increase growth and employment, while at the same time reducing the internal and external imbalances, and safeguarding past gains in macroeconomic stabilization.

One of the centerpieces of the reform program, next to the health reform as discussed above, is the recently-adopted Law on Labor Relations, which, as staff correctly points out, marks a turning point in Macedonia’s labor relations. Its main purpose is to make the labor market more flexible. This law is expected, over time, to have a large impact on growth, foreign investment and the reduction of the shadow economy.

Another critical structural project, which the authorities believe will have a major impact on the business environment, is the ambitious and comprehensive judicial reform program. This program, which will be implemented over the course of several years, aims at strengthening the rule of law by conforming to European standards. Its first stage consists of legislative actions to create a legal and constitutional basis for the new court system. The second stage consists of administrative reforms: improved court administration and budgeting, and the creation of a new enforcement agency. The elaboration of such a comprehensive strategy was possible only with the extensive technical assistance received from donors, including EU institutions and member countries, NATO, and USAID, which is highly appreciated by the Macedonian authorities.

Looking forward, the authorities are confident that the positive outcomes of the labor market and judicial reforms will be complemented by a number of measures to improve the business climate. Such measures will include, among others, reduction in the time and cost needed to open a business; reduction of the excessive number of licensing requirements, improvement of legislative procedures and the institutional framework for corporate governance, and strengthening the institutional framework for bankruptcy and measures to improve land registration.

The authorities’ reform agenda also includes an ambitious privatization program extended to the electricity sector, telecommunications, financial sector and retail property. A partial privatization of the Electricity power company of Macedonia (ESM) are in the final preparation process with support from the EBRD, and the World Bank, which is providing the assessment of the regulatory implications. Furthermore, the government intends to sell its residual shares in the telecommunication sector by mid-2006, and will start tendering its equity in commercial banks by the end of the year.

Finally, I would like to note that the authorities intend to treat the proposed SBA as precautionary after making the initial purchase. The request for an extension of repurchase expectations totaling SDR 5.4 million falling due before end-September 2006 is based on the external financing needs during the next twelve months and the deterioration of the external position relative to the outlook in March, 2003, when the last SBA was approved.


To ‘BB+’ from ‘BB’, and to ‘BBB-’ (investment grade) from ‘BB+’, respectively, the short-term local currency rating to ‘A-3’ from ‘B’, and affirmation of the ‘B’ short-term foreign currency rating.